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The Current Oil Shock

The Current Oil Shock

by

Dilip Hiro

When will it end, this crushing rise in the price of gasoline, now averaging $4.10 a gallon at the pump? The question is uppermost in the minds of American motorists as they plan vacations or simply review their daily journeys. The short answer is simple as well: "Not soon."

As yet there is no sign of a reversal in oil's upward price thrust, which has more than doubled in a year, cresting recently above $146 a barrel. The current oil shock, the fourth of its kind in the past three-and-a-half decades, and the deadliest so far, shows every sign of continuing for a long, long stretch.

The previous oil shocks -- in 1973-74, 1980, and 1990-91 -- stemmed from specific interruptions of energy supplies from the Middle East due, respectively, to an Arab-Israeli war, the Iranian revolution, and Iraq's invasion of Kuwait. Once peace was restored, a post-revolutionary order established, or the invader expelled, vital Middle Eastern energy supplies returned to normal. The fourth oil shock, however, belongs in a different category altogether.

Nothing Like It Before

Unlike in the past, the present price spurt has been caused mainly by global demand for energy outstripping available supply. Alarmingly, there is no short-term prospect that supply will match demand. For a commodity like petroleum that underwrites and permeates every aspect of modern life -- from fuel to fertilizers, paints to plastics, resins to rubber -- "balance" requires a 5% safety factor on the supply side.

At present, however, spare capacity in the oil industry is less than 2%, down from more than 6% in 2002. As a result, the price of oil responds instantly to negative news of any sort: a threat against Iran by an Israeli cabinet minister, a fire on a Norwegian offshore drilling rig, or an attack on an oil facility by armed rebels in Nigeria.

Behind the present price surge, other factors are also at work. Take the sub-prime mortgage crisis in the U.S. It flared almost a year ago, drastically lowering the market value of the stocks of banks and allied companies. The concomitant downturn in other equities led investment fund managers and speculators to direct their cash into more productive markets, especially commodities such as gold and oil, driving up their prices. The continued weakening of the U.S. dollar -- the denomination used in oil trading -- has also encouraged investment in commodities as a hedge against this depreciating currency.

The earlier oil shocks led non-OPEC (Organization of the Petroleum Exporting Countries) nations to accelerate oil exploration and extraction to increase supplies. Their collective reserves, however, represent but a third of OPEC's 75% of the global total. By the turn of the century, these countries had pumped so much crude oil that their collective output went into an irreversible decline.

A mere glance at the oil production table of the authoritative BP Statistical Review of World Energy -- published annually -- shows declines in such non-OPEC countries as Britain, Brunei, Denmark, Mexico, Norway, Oman, Trinidad, and Yemen. Over the past decade, oil output in the U.S. has declined from 8.27 million barrels per day (bpd) to 6.88 million bpd.

The exploitation of the much-vaunted tar sands of Canada -- expected to cover the global shortfall -- only helped to raise that country's output from 3.04 million bpd in 2005 to 3.31 million bpd in 2007, a mere 10% in two years.

In the 1990s, overflowing supplies and cheap oil had led to an overall decline in oil exploration as well as under-investment in refineries. These two factors constitute a major hurdle to hiking the supply of petroleum products in the near future.

In addition, new hydrocarbon fields are increasingly found in deep-water regions that are arduous to exploit. The paucity of the specialized equipment needed to extract oil from such new reserves has created a bottleneck in future offshore production. The world's current fleet of specialized drill ships is booked until 2013. The price of building such a vessel has taken a five-fold jump to $500 million in the last year. The cost of crucial materials -- such as steel for rigs and pipelines -- has risen sharply. So, too, have salaries for skilled manpower in the industry. Little wonder then that while, in 2002, it cost $150,000 a day to hire a deep-water rig, it now costs four times as much.

Static Supply, Rising Demand

While the oil supply remains essentially static, worldwide demand shows no signs of tapering off. The only way to cool the energy market at the moment would be to reduce consumption. Luckily -- from the environmentalist's viewpoint -- soaring gasoline and diesel prices have begun lowering consumption in North America and Western Europe. Gasoline consumption in the United States dropped 3% in the first quarter of 2008, when compared to the previous year.

When it comes to energy conservation, there is a far greater opportunity for saving in the affluent societies of the West than anywhere else in the world. An average American uses twice as much oil as a Briton, a Briton twice as much as a Russian, and a Russian eight times as much as an Indian. It was therefore perverse of U.S. energy secretary Sam Bodman to focus on the way the Chinese and Indian governments subsidize oil products to provide relief to their citizens -- and to urge their energy ministers to cut those subsidies to "reduce demand."

It is true that China and India, which together account for two-fifths of the human race, are now major contributors to the growth in global oil demand. But it's an indisputable fact that only by increasing per capita energy consumption from current abysmally low levels can the Chinese and Indian governments hope to lift hundreds of millions of people out of grinding poverty.

In a country like India, for instance, half of all households lack electricity, so hurricane lanterns, fueled by kerosene, are a basic necessity. Subsidized kerosene, also used for cooking stoves, helps hundreds of millions of poor Indians. To cut or eliminate the subsidy on kerosene would only intensify poverty.

In truth, when it comes to energy conservation, the main focus at the moment should be on the 30-member Organization for Economic Co-operation and Development (OECD), a group of the globe's richest nations which cumulatively consumes nearly three out of every five barrels of oil used anywhere.

Among OECD members, Japan provides a model to be emulated.

Japan's Exemplary Performance

When it comes to energy conservation, Japan provides a glaring counterpoint to the United States. Consider what's happened in both countries since the first oil shock of the mid-1970s when prices quadrupled.

That price hike initially led to a drive for fuel efficiency in the U.S., Western Europe, and Japan. It also gave a boost to the idea of developing renewable sources of energy. Ever since, Japan has followed a consistent, long-range policy of reduction in petroleum usage, while the U.S. first wavered and then fell back dramatically.

Under the presidencies of Gerald Ford and Jimmy Carter, the U.S. modestly improved the fuel efficiency of its vehicles, as stipulated by a federal law. President Carter also announced a $100 million federal research and development program focused on solar power and symbolically had a solar water heater installed on the White House roof.

During the subsequent presidency of Ronald Reagan, when oil prices fell sharply, energy efficiency and conservation policies went with them, as did the idea of developing renewable sources of energy. This was dramatized when Reagan ordered the removal of that solar panel from the White House.

In the private sector, utilities promptly slashed by half their investments in energy efficiency. President George H.W. Bush, an oil man, followed Reagan's lead. And his son, George W. (along Vice President Dick Cheney, former chief executive of energy services giant Halliburton) has done absolutely nothing to wean Americans away from their much talked about "addiction to oil."

Even now, instead of urging Americans to cut oil usage (and putting a little legislative heft behind those urgings), politicians of both parties are blaming soaring gas and diesel prices on "speculators," conveniently ignoring how thin a line divides "speculators" from "investors."

In Japan, on the other hand, the government and private companies have stayed on course since the First Oil Shock. Despite the doubling of Japan's gross domestic product during the 1970s and 1980s, its annual overall levels of energy consumption have remained unchanged. Today, Japan uses only half as much energy for every dollar's worth of economic activity as the European Union or the United States. In addition, national and local authorities have continually enforced strict energy-conservation standards for new buildings.

It is, again, Japan that has made significant progress when it comes to renewable sources of energy. By 2006, for instance, it was responsible for producing almost half of total global solar power, well ahead of the U.S., even though it was an American, Russell Ohl, who invented the silicon solar cell, the building block of solar photovoltaic panels, which convert sunshine into electricity.

What to Do: Medium-Term Solutions

Worldwide, over half of all oil is used for transport. Though we instantly associate a car or truck with an internal combustion engine (ICE), it was not always so. At the turn of the twentieth century, cars were also powered by steam engines or batteries.

Now, our salvation lies in finding a way back to the pre-ICE era. It is incumbent upon the automobile companies in rich nations to accelerate the process of divorcing vehicles from the internal combustion engine. Cars of the future can be powered by batteries, hydrogen cells, or solar panels -- or a combination of the above.

Typically, Japanese companies are in the forefront of research and development on this. It was Toyota which first introduced a "concept" hybrid car in 1995, combining batteries with the internal combustion engine, and began mass producing them some years later.

This June, Honda set up an assembly line for producing a hydrogen-powered car, the FCX Clarity. This model already can travel 280 miles on a tank of liquid hydrogen. But it will go into mass production only after there is an infrastructure of liquefied hydrogen stations in place in Japan and in California, which will take time. So far there are only 13 hydrogen stations, funded by the government, in the Tokyo area. Meanwhile, aware of the enormous cost of its product, it is initially planning to lease the FXC Clarity to drivers for $600 a month.

Another Japanese corporation, Mazda, has come up with a hybrid car using hydrogen cells as well as an internal combustion engine.

As the mass production of non-ICE cars takes off in rich nations, the cost will fall, and such models will find markets in the fast expanding (yet comparatively poor) economies of China and India.

Medium-Term: The Nuclear Option

Besides powering transport, oil is a major source of fuel for electricity-generating plants. With even Royal Dutch Shell CEO Jeroen van der Veer conceding publicly that we are nearing peak oil production (after which oil reserves will decline irretrievably), attention is increasingly turning, in the West, to coal and nuclear power as medium-term solutions.

The very mention of nuclear plants revives nightmarish memories of the partial meltdown of a U.S. reactor at Three Mile Island in Pennsylvania in 1979, and the catastrophic burning of the Chernobyl nuclear plant in Ukraine in 1986. On the other hand, nuclear stations now provide 79% of France's electricity and have, so far, been accident-proof. That country's leading nuclear company, Areva, expects to sell 100 power stations, fueled by third-generation Evolutionary Pressure Water Reactors (EPWR), worldwide by 2030.

Areva also heads a consortium that is building the first nuclear power station in Europe in more than a decade -- in Finland. On nuclear waste management and safety, the Finnish nuclear authority Posiva seems to have found a workable solution. After twelve years of public debate, it has allowed the construction of a $3.5 billion nuclear plant equipped with an EPWR reactor, on an offshore island.

The new plant is designed to last 60 years, twice the average life of a nuclear power plant today. If its control rods should fail, triggering a core meltdown, a special basin of concrete will be there to hold the debris, thus theoretically preventing the release of radioactive material. The nuclear waste will then be set in cast iron, encased in copper, and dropped down a borehole, half a kilometer deep, which would, in turn, be saturated with bentonite, a kind of clay. According to Posiva's metallurgists, under such conditions the copper barrier should last a million years.

Once this station is commissioned, nuclear-fueled electricity will rise from 27% to 37% of the total on the Finnish national grid.

So acute is the demand for electricity in India that three nuclear power stations are to be commissioned this year. Once on line, however, these plants will make but a marginal difference in meeting Indian energy needs. Only coal, which abounds in India, can help meet exploding demand, as is true in coal-rich China. There, an electric plant fueled by (dirty, conventional) coal is being commissioned every week.

Medium-Term: Cleaner Coal

In the hydrocarbon family, coal is the least efficient energy source, providing only half as much energy as oil, while producing twice as much carbon dioxide (CO2). But coal has the longest history of supplying energy to modern societies, and as the twenty-first century began, it was still one of the leading fuels for power plants worldwide.

Today, coal provides 28% of electric power globally, only marginally less than in the 1970s. Countrywide, percentages vary widely -- from 20% in the United States to four times as much in China.

Because coal isn't going away any time soon, the challenge is obviously to burn coal more efficiently and, at the same time, capture its CO2 emissions before they reach the atmosphere. One possible solution to coal's polluting problems lies in producing de-carbonized coal -- that is, in converting coal into petroleum products, thereby also reducing demand for crude oil. A hybrid technology involving de-carbonizing natural gas or coal already exists. In a coal-fired integrated gasification combined cycle (IGCC) facility, coal is broken up, extracting the hydrogen and leaving behind the carbon. Next the hydrogen is burned, emitting heat that drives the electricity-generating turbines, while carbon, in the form of liquefied CO2, is stored underground or under the seabed.

But, at the moment, an IGCC station needs one-fifth more coal as fuel than a conventional plant just to produce the energy needed to power the carbon-capturing mechanism. The price of the electric power thus generated would be a third to a half higher than that from dirty coal.

On the other hand, according to the United Nations' Intergovernmental Panel on Climate Change (IPCC), the CO2 capture and storage (CCS) system could someday provide up to 55% of the emissions reduction needed to avoid the worst effects of global warming. Last month, the G8 energy ministers, meeting in Japan, called for the launch of 20 large-scale CCS projects globally by 2010. Soon after, the British government invited four leading European companies to submit tenders for such a project in the United Kingdom.

At the recent oil summit in Jeddah, British Prime Minister Gordon Brown announced that his country would work with Saudi Arabia on perfecting the technology for carbon capture. The United States and Australia are already committed to advance this technology with public funds. As it gets cheaper with frequent application, it will become affordable by countries like India and China.

With oil supplies peaking in the coming years and uranium following a similar path as the present century unfolds, the weight of humanity's needs will increasingly fall on coal. It is coal, for better or worse, that will provide the energy to sustain higher living standards for a growing segment of humanity, even as the search for, and development of, renewable energies proceeds at a faster pace. Last week, recognizing this reality, the G8 summit renewed its commitment to advance carbon capture and storage systems with all due speed.

This, in a nutshell, is the global energy future in the medium term. It is the reality we face.

Dilip Hiro is the author of numerous books on the Middle East. His most recent book, Blood of the Earth: The Battle for the World's Vanishing Oil Resources (Nation Books) is a vivid history of how oil has revolutionized civilian life, war, and world politics over the last century, as well as of alternatives to oil, including renewable energy sources.

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